Price competition is a core element of a free market economy. In setting prices, companies are not usually free to charge whatever prices they wish. Many European and national laws govern the rules of fair play in pricing. In addition, companies must consider broader soci- etal pricing concerns. Legislation is in place in all of the world’s major economies to prohibit anti-competitive pricing practices. For example, in Europe the most important legislation affecting pricing is Article 81 of the EU Treaty.
Figure 9.6 shows the major public policy issues in pricing. These include potentially damaging pricing practices within a given level of the channel (price fixing and predatory pricing) and across levels of the channel (retail price maintenance, discriminatory pricing and deceptive pricing).18
In the EU, anti-competitive business practices are prohibited by Article 81 of the EU Treaty:
The following shall be prohibited as incompatible with the common market: all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market, and in particular those which:
a. directly or indirectly fix purchase or selling prices or any other trading conditions;
b. limit or control production, markets, technical development, or investment;
c. share markets or sources of supply;
d. apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage;
e. make the conclusion of contracts subject to acceptance by the other parties of supple- mentary obligations which, by their nature or according to commercial usage, have no connection with the subject of contracts.19
The aim of Article 81 is to promote free competition and free trade throughout the EU.
Many member states have their own further legislation to prevent anti-competitive practices in general and unfair pricing practices specifically.
FIGURE 9.6 Public policy issues in pricing
Source: Reprinted with permission from Journal of Public Policy and Marketing, published by the American Marketing Association, L.D.
Compeau and D. Grewel,
‘Pricing and Public Policy:
A Research Agenda and Overview of Special Issue’, Journal of Public Policy and Marketing, Spring 1999, pp. 3–10, Figure 1.
Before you leave pricing behind, let’s review the important concepts. Price can be defined as the sum of all the values that customers give up in order to gain the benefits of having or using a product or service. Pricing decisions are subject to an incredibly complex array of company, environmental and competitive forces.
1 Discuss the importance of understanding customer value perceptions and company costs when setting prices
Good pricing begins with a complete understanding of the value that a product or service creates for customers and setting a price the captures that value. The price the company charges will fall somewhere between one that is too high to produce any demand and one that is too low to produce a profit.
Customer perceptions of the product’s value set the ceiling for prices. If customers perceive that the price is greater than the product’s value, they will not buy the product. At the other extreme, company and product costs set the floor for prices. If the company prices the product below its costs, its profits will suffer.
Costs are an important consideration in setting prices. However, cost-based pricing is product driven.
The company designs what it considers to be a good product and sets a price that covers costs plus a target profit. If the price turns out to be too high, the com- pany must settle for lower mark-ups or lower sales, both resulting in disappointing profits. Value-based pricing reverses this process. The company sets its target price based on customer perceptions of the product value.
The targeted value and price then drive decisions about product design and what costs can be incurred. As a result, pricing begins with analysing customer needs and value perceptions, and price is set to match customers’
perceived value.
2 Identify and define the other important external and internal factors affecting a firm’s pricing decisions Other internal factors that influence pricing decisions include the company’s overall marketing strategy, objec- tives, mix and organisation for pricing. Price is only one element of the company’s broader marketing strategy. If the company has selected its target market and position- ing carefully, then its marketing mix strategy, including price, will be fairly straightforward. Some companies position their products on price and then tailor other marketing mix decisions to the prices they want to charge.
Other companies de-emphasise price and use other marketing mix tools to create non-price positions.
Common pricing objectives might include survival, current profit maximisation, market-share leadership, or customer retention and relationship building. Price decisions must be coordinated with product design, dis- tribution and promotion decisions to form a consistent and effective marketing programme. Finally, in order to coordinate pricing goals and decisions, management must decide who within the organisation is responsible for setting price.
Other external pricing considerations include the nature of the market and demand, competitors’ strate- gies and prices, and environmental factors such as the economy, reseller needs and government actions. The seller’s pricing freedom varies with different types of markets. Ultimately, the customer decides whether the company has set the right price. The customer weighs the price against the perceived values of using the product – if the price exceeds the sum of the values, consumers will not buy. So the company must understand concepts like demand curves (the price–demand relationship) and price elasticity (consumer sensitivity to prices). Consum- ers also compare a product’s price with the prices of com- petitors’ products. A company therefore must learn the customer value and prices of competitors’ offers.
3 Describe the major strategies for pricing imitative and new products
Pricing is a dynamic process. Companies design a pricing structure that covers all their products. They change this structure over time and adjust it to account for differ- ent customers and situations. Pricing strategies usually change as a product passes through its life cycle. In pric- ing innovative new products, it can follow a skimming policy by initially setting high prices to ‘skim’ the maxi- mum amount of revenue from various segments of the market. Or it can use penetration pricing by setting a low initial price to penetrate the market deeply and win a large market share.
4 Explain how companies find a set of prices that maxim- ises the profits from the total product mix
When the product is part of a product mix, the firm searches for a set of prices that will maximise the profits from the total mix. In product line pricing, the company decides on price steps for the entire set of products it offers. In addition, the company must set
THE JOURNEY YOU’VE TAKEN Reviewing the concepts
prices for optional products (optional or accessory prod- ucts included with the main product), captive products (products that are required for use of the main product), by-products (waste or residual products produced when making the main product) and product bundles (combina- tions of products at a reduced price).
5 Discuss how companies adjust their prices to take into account different types of customers and situations Companies apply a variety of price adjustment strategies to account for differences in consumer segments and sit- uations. One is discount and allowance pricing, whereby the company establishes cash, quantity, functional or sea- sonal discounts or varying types of allowances. A second strategy is segmented pricing, whereby the company sells a product at two or more prices to accommodate differ- ent customers, product forms, locations or times. Some- times companies consider more than economics in their pricing decisions, using psychological pricing to better communicate a product’s intended position. In promo- tional pricing, a company offers discounts or temporarily sells a product below list price as a special event, some- times even selling below cost as a loss leader. Another approach is geographical pricing, whereby the company decides how to price to near and distant customers.
Dynamic pricing involves adjusting prices continually to meet the characteristics and needs of individual custom- ers and situations. Finally, international pricing means that the company adjusts its price to meet conditions and expectations in different world markets.
6 Discuss the key issues related to initiating and respond- ing to price changes
When a firm considers initiating a price change, it must consider customers’ and competitors’ reactions. There are different implications to initiating price cuts and ini- tiating price increases. Buyer reactions to price changes are influenced by the meaning customers see in the price change. Competitors’ reactions flow from a set reaction policy or a fresh analysis of each situation.
There are also many factors to consider in respond- ing to a competitor’s price changes. The company that faces a price change initiated by a competitor must try to understand the competitor’s intent as well as the likely duration and impact of the change. If a swift reaction is desirable, the firm should pre-plan its reactions to differ- ent possible price actions by competitors. When facing a competitor’s price change, the company might sit tight, reduce its own price, raise perceived value, improve qual- ity and raise price, or launch a fighting brand.
NAVIGATING THE KEY TERMS
Allowances 318 Break-even pricing 305 By-product pricing 316 Captive-product pricing 316 Cost-plus pricing 305 Demand curve 311 Discount 317 Dynamic pricing 323 Fixed costs 305
Geographical pricing 322
Good value pricing 303 Market-penetration pricing 314 Market-skimming pricing 314 Optional-product pricing 315 Price 300
Price elasticity 312 Product bundle pricing 317 Product line pricing 315 Promotional pricing 321 Psychological pricing 319
Reference prices 319 Segmented pricing 318 Target costing 307 Target profit pricing 305 Total costs 305
Value-added pricing 303 Value-based pricing 301 Variable costs 305
NOTES AND REFERENCES
1 Thomas T. Nagle and Reed K. Holden, The Strategy and Tactics of Pricing, 4th edn (Upper Saddle River, NJ: Prentice Hall, 2005), ch. 1.
2 Information obtained online at http://corporate.walmart.com/our-story, accessed January 2014.
3 Information obtained online at http://franchisor.ikea.com, accessed 7 May 2007.
4 A. Hinterhuber, ‘Towards Value-Based Pricing – An Integrative Framework for Decision Making’, Industrial Marketing Management, 33, 2004, pp. 765–78.